How banks will benefit from infrastructure services in India

Indian banks are staring at the prospect of an increase in non-performing assets, mainly due to their large exposure to infrastructure sector.  Infra sector has been affected by govt. policies (effects most visible in power sector) and the general economic slowdown, which has resulted in lower demand across-the-board. 

The projects have also suffered owing to delays due to issues in land acquisition, environmental approvals, inadequate feedstock supply, lack of sufficient offtake mechanisms, etc.

The banks would need to manage their existing exposures, and have understandably become far more conservative in taking fresh exposures in new infrastructure projects.  In this scenario, going forward, it would be advisable for banks to increase their focus on infra-services businesses. 

There are a large number of such companies already in existence - essentially these firms are the ‘support’ for infrastructure projects.

Examples include:

Electronic tolling services, Management of highways, Port handling & loading / unloading, Logistics solution providers, Transporters, Warehouses, Cold chains, Aviation ground handling, Coal washery, Smart grid, Metering, Operations and maintenance, Remote IT infrastructure management, Management of passive telecom infrastructure, etc.

There can be many more examples of such businesses, which are ‘enablers’ for core infrastructure projects.  Infra Services companies have been seeing a fair amount of Private Equity interest as well, which also validates the argument of higher ‘bankability’ of these businesses. 

From the lenders’ perspective, higher focus on these sectors offers significant advantages (over large infra projects):

·More stable, and less volatility in demand – generally not dependent on a single buyer and hence offtake risk is reduced

·Less vulnerable to regulatory risk

·Smaller in size – need less capital

·Lesser issues like environmental approvals, which are critical for large infra projects

·The businesses have been started by a multitude of promoters all over the country – hence, from banks’ perspective, there is less issue of over-concentration of risk in certain large promoter groups.

As Indian economy grows, these sub-sectors would become more important, and large businesses in their own right.  Some of these sectors get a lot of importance in developed economies, e.g. highway tolling is a big business in Europe, and countries like Malaysia; independent telecom tower companies are large businesses in US.

From the macro perspective, having an efficient infra-services sector is critical to maintain the efficiency of infra projects and prevent wastage.  This is especially true in a capital-scarce economy like India.  For instance, efficient repair and refurbishment can significantly enhance the life of old thermal power plants, at a fraction of the cost (and efforts) of setting up a new power plant.

There are significant externalities in some cases – e.g. considering the high ash and stone content in Indian coal, setting up a coal washery near the coal mine reduces the requirement of rail wagons for transport of coal to end-users.  Govt. needs to give (some kind of) infra status to these sectors, to enable easier funding.

Issues that the banks need to be careful of:

· Govt. has mandated Infrastructure Development Funds and IIFCL to reduce the banks’ exposures in infra sectors.  These schemes will not apply to infra services companies.  Since the credit offtake has slowed down of late, this is not an important factor in the short term, but could become important as the economy picks up.

·Tendency of Indian promoters to over-stretch themselves – it has been seen in some areas, for instance telecom towers, that certain companies took on commitments based on highly optimistic projections – and when the actual performance was not as rosy, they had problems servicing their debt. 

·Since the macro indicators of India in infra are so poor, it is easy to get carried away by the aggressive top-down, per capita-based projections, without taking ground realities into account. Lenders need to be careful of business plans based on such assumptions

·Importance of local conditions – some concepts which have worked in developed markets and appear nice on paper, may flounder in Indian conditions.  For example, transportation of fresh produce is a challenge due to unreliable cold chains – time taken on the road can vary a lot due to road diversions, delays at checkpoints, etc.